Key Highlights
'You can take a horse to water, but you can't make him drink' - that's, perhaps, a suitable phrase to describe the current situation of Indian banks.
The Reserve Bank India (RBI), as the regulator, has bombarded the banks with surplus liquidity to help coronavirus-hit sectors, but the banks are unlikely to pass it on.
The RBI has redrafted its strategy to force banks to lend. All doors have been shut for banks to redeploy surplus funds back to the central bank. Also, RBI has incentivised banks to offer liquidity to small & mid-sized NBFCs and MFIs.
Will the banks follow the RBI?
It looks highly unlikely unless the government provides a guarantee to commercial lending institution to take a bet in the sector and the company in the midst of an unpredictable economic situation post the lockdown.
Currently, the probability of loan defaults in the near future is very high. But the combo of government and the bank can help in a seamless flow of liquidity. Let's understand the current gaps in the liquidity strategy.
Low credit growth was forcing banks to deposit money with RBI
There was no dearth of liquidity even before the coronavirus outbreak in India. The banks were flush with liquidity because of low credit growth. In fact, the credit growth halved to 6.1 per cent in 2019-20 as compared to previous year. The banks were also not comfortable to lend to weak companies in a slowing economy. In the month of March, the banks were parking around Rs 3 lakh crore of surplus funds with RBI on a daily average basis under the reverse repo. So. liquidity was not at all an issue for banks.
Additional liquidity of Rs 3.74 lakh crore increased surplus funds
The RBI knew very well that there was additional liquidity, but the surplus liquidity was created to help the economy neutralise coronavirus impact. The RBI had also reduced the reverse repo rate to 4 per cent thereby discouraging the banks to redeploy their funds with the central bank. The reverse repo rate is the rate at which RBI absorbs surplus funds from the banks. But that plan didn't work as shown in the liquidity absorption figures released by the RBI Governor today. The banks flush with funds were happily deploying funds back to RBI at 4.0 per cent rate under the reverse repo. With the repo rate at 4.40 per cent, savings rate at 2.75-3 per cent, zero current account rate, the economics of deploying surplus funds was in favour of banks. That shows up in the surplus funds parked with RBI. The average net liquidity surplus absorbed by the RBI has been to the tune of Rs 4.36 lakh crore in the two weeks. On April 15 alone, the amount absorbed under reverse repo operations was Rs 6.9 lakh crore.
RBI's new plan
The banks will once again devise new ways to protect commercial interest. First, there is likely to be further fall in deposit rates. The fixed deposit rates will also come down. This reduction in the cost of funds will encourage them to park a part of their funds back to the RBI. Similarly, the current Rs 25,000 crore long term repo facility out of Rs 50,000 crore is not sufficient for small and mid-sized NBFCs and MFIs. The risk averse banks will once again find strong mid and small size NBFCs to fund. The ones that need money will once again be left out.
Need of the hour - Govt guarantee for small loans
The banks are commercial entities. They have a liabilities side which comprises of their capital, reserves and the deposits. There is a obligation to pay interest on deposits and return to the shareholders who owns the capital. The assets side is largely the loan book. In the current circumstances when the chances of defaults are very high, the banks would be very cautious in lending to many sectors of the economy. In fact, the government has to come forward with an economic package including some sort of a guarantee to banks, which will provide comfort to lenders to help the sector and the companies.
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